They are trying to cash in on the sharp rise in short-term rates following a slew of measures taken by the Reserve Bank of India to tighten liquidity in the banking system to shore up a flagging national currency.

"The tightening has led to a higher rise in short-term rates than the long-term rates. Investors should lock in their funds into one-year FMPs to benefit from this hike," says Dhruva Raj Chatterji, senior investment consultant, Morningstar India.

After the RBI restricted the availability of funds for banks, one-year certificate of deposit (CD) rates went up to 10% from 8.3%, a rise of 170 basis points, before stabilising at 9.5%. What it means is that after deducting expenses of half per cent, these one-year FMPs could give you a pre-tax return between 9-9 .5% — a good bet for investors who don't want to expose themselves to the interest rate risk.

"Invest in a combination of FMPs and bank deposits. If you feel you may need the money sometime within a year, use a bank deposit. Otherwise , go for an FMP," says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

FMPs Make Sense Now

The recent RBI measures have put a big question mark on the future course of interest rates. Since the banking regulator has chosen an indirect method to curb liquidity, most banking experts are unsure about which way the rates would move in the near to medium term.

There are many who believe that the banking regulator may reverse these measures as soon as the rupee settles at a level comfortable to the central bank. That is why many investors prefer to lock-in their money at current levels, especially because the volatility in the debt market has eaten into their earnings from debt funds.

"An FMP buys securities that will mature more or less on the same time the fund matures. So there is no interest rate risk for an investor holding an FMP till maturity," says Debashish Mallick, MD and CEO, IDBI Mutual Fund.

Checking on FMPs

Though no fund house can declare the portfolio of a scheme beforehand , or indicate the returns expected , investors can get a fair idea of what to expect by checking the portfolios of similar schemes launched in the recent past. Such portfolios are available in factsheets of fund houses or with mutual fund tracking agencies such as Value Research.

Go with fund houses that invest in AAA corporate bonds or PSU bonds. "If the fund house has earlier invested in such bonds, it is likely that they will stick to that approach and not opt for lower quality paper, which may carry higher risk," says Anup Bhaiya, MD and CEO, Money Honey Financial Services.

FMPs are tax efficient too, especially for those in the high tax bracket. If you opt for the growth option, long-term capital gains tax liability would be lower of 20.6% with indexation or 10.3% without indexation. Assuming a pre-tax return of 9%, the post-tax returns in an FMP could be 8.05%. Compared with this, a one-year bank fixed deposit that offers 8.5%, would only earn around 6% for investors in the highest tax bracket of 30.6%.

Liquidity is a Worry

The major drawback of FMPs is illiquidity . Although they are listed on exchanges, they are hardly traded . Even in cases where trading takes place; it happens at a huge discount to the NAV. That means it will be very difficult for an investor to get out of these schemes before maturity. That is why experts advice clients who are unsure about their liquidity requirement, to settle for a bank fixed deposit. "Bank deposits are very liquid. If you need the money, all you have to do is walk to the nearest branch," says Vishal Dhawan.